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Quilter Cheviot: Why we’re taking some risk off our UK and US fund exposure

06 June 2017

Portfolio manager Simon Doherty explains why he has added passive exposure alongside his active managers in the UK and US for the first time.

By Jonathan Jones,

Reporter, FE Trustnet

After a challenging 2016 for UK funds tilted towards the lower end of the market cap scale Quilter Cheviot’s Simon Doherty has set about tabling some of the risk in its model portfolios by adding large-cap exposure.

Doherty became the lead manager of the model portfolio range just days before the EU referendum in June 2016 and has since been reviewing its successful and longstanding investment service.

“One of the areas that we looked at in quite a lot of detail in the wake of Brexit – and I think a lot of people did as well – was the allocation that we had within the UK,” he said.

Last year was a particularly challenging environment for a lot of active managers, who have typically been overweight mid-cap stocks.

Indeed, as the below graph shows, since the Brexit vote in June 2016, the large-cap FTSE 100 has outperformed the FTSE 250 mid-cap index.

Performance of indices since EU referendum

 

Source: FE Analytics

“I think I remember reading there were historic lows in terms of the percentage of active managers that managed to outperform over that period,” Doherty said.

The immediate sell-off in the 48 hours following the vote hit the mid-cap sector particularly hard as concerns over the UK domestic economy outside of the EU surfaced.

This was coupled with a return to form for large mega-cap overseas earners which have driven the gains in the FTSE All Share since the initial shock subsided.

The manager said the profound effects of last year, which also included the pound slumping and subsequently boosting the larger more internationally-facing stocks, meant he had to rethink some of the fund holdings within the portfolios.

“We introduced a number of funds and one of the main things that we were keen to do was to increase our overall weighted market cap within the UK equity component of our model portfolio service,” he said.


“One of the things we did was to introduce a very plain vanilla FTSE 100 tracking fund so anchoring some of the higher risk more concentrated exposures that were being expressed on the active side by our managers that we retained and still have significant conviction in.

“We essentially gained this exposure to certain sectors and areas of the market that typically a lot of managers have been quite materially underweight in recent years be that oil & gas, basic materials or financials among a number of other examples as well.”

However, the manager stressed that while these moves were important, on a read-through basis the portfolios are still quite materially tilted down the market cap relative to the broader FTSE All Share.

“It was just to neutralise that position slightly in the wake of what we felt was quite a fast-changing, fast-paced environment in the wake of the vote,” he said.

“We still have exposure to mid- and small-cap segments and have a dedicated small-cap holding within the portfolio – Philip Rodrigs at River & Mercantile – which has certainly benefited us since we introduced that but it was a decision we took based on what we felt was an uncertain backdrop.

“Our view was that the global nature of the FTSE 100 index – those internationally derived revenue streams – could provide us with some protection against this uncertain domestic backdrop and some of the issues that could come to the fore in the succeeding months.”

He bought the five crown-rated passive, £572m L&G UK 100 Index Trust, as well as the Old Mutual UK Alpha fund managed by Richard Buxton.

Performance of fund, tracker and FTSE All Share since EU referendum

 

Source: FE Analytics

The £2.2bn fund, which has a good five-year track record but has struggled over three years, has a more large-cap focus, with HSBC, Lloyds and Royal Dutch Shell the top three holdings in the portfolio.

“One of the things that I was keen to implement at the time was to ensure a lot of close relationships with our investment fund research team,” Doherty explained.

“A fund that has always been highly recommended and a high conviction idea was Richard’s fund but it wasn’t in the managed portfolio service strategies at the time.


“I felt that was an opportune moment given the difficulties that we’d seen in terms of performance and some of the characteristics of that fund that we wanted to introduce.”

The other fund he introduced, which was held in one of the strategies but not on a wider basis, was Artemis Income managed by Adrian Frost.

“Again we felt it was an opportune time to buy into a process that we thought had a fantastic track record,” the manager said.

“We felt very comfortable in terms of the positioning that he had – companies with strong free cashflow, strong balance sheets – and he is relatively low turnover in terms of process so that was another change we made at the time as well.”

The other area he has upped generic market exposure to is the US, where he owns three very different funds - PrivilEdge Sands US Growth, Iridian US Equity and Vulcan Value Equity.

Performance of funds and S&P 500 over 3yrs

 

Source: FE Analytics

“Sands is your very much out-and-out growth orientated manager with very large exposure to the FANGs [Facebook, Amazon, Netflix and Google] to technology in particular while Vulcan is a value-orientated manager,” Doherty said.

“Iridian is very much more of a mid-cap focused manager looking at corporate change as a catalyst to unlock shareholder value working very closely with management teams in the mid and smaller segments of the market cap.”

He added: “We’ve got three managers there that we do rate very highly and have undoubtedly over the last couple of years – in line with a lot of active managers – struggled.

“And that’s not to say that we have lost faith or confidence, we’ve retained those managers but we’ve brought in alongside them the allocation to an index fund to essentially give us exposure to sectors that as a result of their process and approach they might be happy to zero weight.

“We want to try and mitigate some of that tracking error from three managers that we think over the longer term can certainly add value to overall returns on a relative basis.”

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